Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, North Industries Group Red Arrow Co., Ltd (SZSE:000519) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is North Industries Group Red Arrow's Net Debt?
As you can see below, at the end of December 2023, North Industries Group Red Arrow had CN¥339.6m of debt, up from CN¥170.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥6.50b in cash, so it actually has CN¥6.16b net cash.
A Look At North Industries Group Red Arrow's Liabilities
The latest balance sheet data shows that North Industries Group Red Arrow had liabilities of CN¥4.31b due within a year, and liabilities of CN¥779.3m falling due after that. Offsetting this, it had CN¥6.50b in cash and CN¥2.10b in receivables that were due within 12 months. So it can boast CN¥3.51b more liquid assets than total liabilities.
This surplus suggests that North Industries Group Red Arrow is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that North Industries Group Red Arrow has more cash than debt is arguably a good indication that it can manage its debt safely.
Also good is that North Industries Group Red Arrow grew its EBIT at 11% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine North Industries Group Red Arrow's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While North Industries Group Red Arrow has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, North Industries Group Red Arrow recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that North Industries Group Red Arrow has net cash of CN¥6.16b, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 11% in the last twelve months. So we don't think North Industries Group Red Arrow's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - North Industries Group Red Arrow has 1 warning sign we think you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.